2009-11-28

I spent part of my youth in a country with a social "safety net" medicine scheme and benefited from it. Not perfect but it beats treating your poor in the emergency room and then passing the unrecovered costs along in insurance premiums on everyone else. Bad health is a crap shoot, and some sort of universal sharing of the risks is at least part of the properly engineered system to deliver health. So, despite my general preference for individual resposibility and minimal government interference, this is one area I was open to seeing if a sensible redesign of the US health system and some government role might be possible.

Now the USA can argue many things about why the enormous money spent does not add up to great health for all - but one thing everyone pretty much agrees on is the system is wasteful. The estimates range from $300Bn to $500Bn of waste - the low number comes from doing the accounts and the high number comes from benchmarking ratios of budget spent on care versus overall budget against other nations. Ballpark, 20% waste. And mind you, we are not talking about the cost of the insurance industry here. This is 20% waste after your insurance company pays its salesforce, staff, and takes a profit. Ask a Republican or ask a Democrat and they will agree this is a bad thing and one of the main arguments raised to move the issue into gear this year.

Hey, sounds like an ideal opportunity for bipartisan results right? Both parties agree the problem exists, and a few hundred $Bn saved is a plum that many a lawmaker would love to go back to constituents and say "all my work!". But the strange thing is, the bipartisan unity was that none of what they actually did seems to have anything to do with solving this waste.

Instead we got two things. We got a pathetic half effort at allowing a public option for insurance, and we got 2,000 pages of new rules for the insurance companies to navigate. Oh, and for you and me to navigate too. Joy. Will any of this reduce costs or eliminate waste? Of course not. 2,000 pages of federal regulations and a new entitlement agency should be a bitter poison for both liberals and conservatives to swallow.

What was that oath again? "First, do no harm?" Well I guess there is one thing to be thankful about our governing representatives - they are not practicing medicine.

But seriously, Representatives and Senators. This is just so horribly wrong. Can't you feel how badly this process is betraying the people you represent? Is this your idea of representative democracy? Do you think the USA can be great if you keep screwing us around like this?

Clearly Capitol Hill is incapable of seeing how seriously dysfunctional it has become, if this kind of disastrous burden is the only work product it can imagine and deliver.

2009-02-12

If you ever read one of those quaint old books on banking - you know, the ones written maybe 10 years ago - you will see them mentioning a curious concept. Managing risk.

Banking has at its heart a behavior which is very risky. Banks borrow short, and lend long. This is risky because a short term loan (like your savings balance or your 3 month CD) may be withdrawn, while the bank's long term obligations (like your neighbor's mortgage) can remain on the books for 25 years. Now, since the bank's source of funds is primarily short deposits like yours there is obviously some alchemy going on to generate 25 year loans.

It used to be that the alchemy was done with a trifecta of advantages the bank had:- it has lots of deposits, with average behavior that can be trusted- it has a core of long term capital to smooth over the slight variations- it is very careful to minimize other sources of risk

And there you have it, the banking system that can be recognized from "It's a wonderful life", a nice little earner which fueled our economy steadily for about 70 years.

Two things changed recently. The first is that securitizing the long term loans replaced bank depositors with a new class of investor, who previously would have invested in bonds. These investors lend long too, and are expected to manage their own risks. Sort of. Anyway, the bank was relieved of the alchemy of turning short loans into long ones, and in making this change banks felt themselves become free to take risks.

The more insidious and troubling change is the conversion of banking culture to a system of bonus rewards. The problem is, bonuses reward risky behavior. Modern banking is an exercise in statistics, well understood by the bankers. So if you are managing some money and fail to hit your targets, well everyone knows it is not your fault. You still get your salary. Not everyone can be above average. Maybe if you are consistently under the average you will move into a nice quiet job in the bank - hey, they still have those. But, if you are lucky the funds you manage will beat the average. Now you are eligable for a bonus. And as we have seen these can be very big.

But, fundamentally all the bonus is rewarding is risky behavior. Suppose you did like banks used to do and managed a portfolio for steady gains and low risk. If you do that then you will have no chance of a big bonus. It is much more interesting to play a high risk strategy which could have a higher gain. Now, maybe you will just collect your salary. Or maybe, just maybe you will be in the 10% lucky sods who have the luck to seriously outperform and collect the big $ bonus.

Since the baseline is "collect a salary" and there is minimal penalty on failure, while the bonus for luck will be enough to retire on (well if you were not Wall Street greedy), the clear best strategy is to create investments with high likely gain and who cares if they have, inevitably, high risk.

So the fundamental problem with bonusses on Wall Street is that mostly they are not rewarding the best. They are rewarding the riskiest. And if we want to trust our banks that culture has to be eliminated. And the fear that the "best and brightest" will be driven away? Nah, they'll fly away. Vegas is too far for them to want to drive.